Beyond Bulls & Bears

Equity

Notes from the Trading Desk – Europe

The Digest

Global equities were fairly stable to start last week, but sold off towards the end of the week as concerns over headlines regarding US/China trade relations weighed on sentiment. The ongoing tensions have been a market driver for some time, and it looks like they will remain so indefinitely. Last week, investors were also concerned that we may face a second wave of the coronavirus, leading to a slower reopening of economies. With this, the STOXX Europe 600 Index closed the week down 3.8%, with all sectors in the red. The US S&P 500 Index closed the week down 2.3%, whilst the MSCI Asia Pacific closed down 1.2%.1

In Europe, the rotation between recent winners/losers and momentum/value was a key theme, with this dynamic driving both single stock and index moves throughout the week. From a sector perspective, the defensive health care and telecommunication stocks outperformed on the week once again, whilst the banks had a torrid week, approaching all-time lows. Travel and leisure also suffered, unsurprisingly, as the true impact of the shutdown remains unknown. Health care is now the only positive European sector year-to-date, and playing a similar role to the S&P 500 FANG2 names in propping up the STOXX Europe 600 Index recovery.

Whilst the rotation we’re seeing does tie in with the daily noise surrounding the pandemic, it does feel like positioning, rather than anything fundamental, is driving this dynamic, especially as at times we see the direction switch day to day. With this being such a strong market structure theme at present and earnings so hard to predict right now, it really does feel like individual stock news and fundamentals can become lost, with performance primarily driven by which basket you fall in and what that basket is doing on the day.

US/China Trade Tensions

Trade rhetoric between the United States and China is now firmly back in focus, with inflammatory headlines from either side breaking last week. US President Donald Trump said he doesn’t want to talk to the President of China, Xi Jinping, right now and that he may consider cutting ties with China altogether. He also spoke about re-assessing Chinese companies that trade on US stock exchanges as they do not follow certain  accounting rules. There were reports that Chinese trade advisors were pushing for the initial trade deal to be re-negotiated as they believe the United States is in a weaker negotiating position given the current economic downturn. President Trump said there will be no re-negotiation.

The technology space was in particular focus as the United States Commerce Department announced new restrictions which prevent US companies from supplying Chinese technology companies with hardware and software. There was also a new rule that would mean any supplier to Huawei which uses US technology would be required to gain a license from the US government before it can sell to the company. At a time when we see supply chains severely impacted by coronavirus lockdowns globally, this will certainly add a further strain. The impact was clear on the US technology space, with the Philadelphia Semiconductor Index closing the week down 4.2%.

COVID-19 Update: Further Easing of Lockdowns

Government lockdowns across some key markets have eased slightly in the last week, but concerns over the potential of a second wave of infections still persist. There has also been a change in sentiment regarding how a potential economic recovery would look, moving from a V-shaped recovery to an L/U-shaped recovery. In other words, where previously market expectations were for a sharp bounce in economic performance, recent data suggests this recovery may be longer and more drawn-out than initially thought.

Firstly, we may consider the easing of lockdown measures we have seen so far.

France has begun to open some business, shops and schools for the first time in eight weeks. However, the country remains split into green and red zones depending on the rate of infection in these zones. The red zone areas, including Paris, remain under strict control. Masks are mandatory in all regions on public transport and in schools. Last week, the French government announced a €18bn fiscal package for supporting tourism—which represents around 9% of French gross domestic product (GDP).

Spain also began phase one of its plan. Some restaurants and hotels have opened with capacity constraints, whilst shops and food markets are also set to re-open with strict social distancing rules in place. Healthy people are allowed to gather in groups of up to 10.

In Germany, further easing was brought in over the weekend as restaurants and hotels were allowed to open with strict hygiene and social distancing measures in place. However, for three consecutive days at the start of last week, the rate of infection (the R number3) rose in Germany back above 1.

German GDP was reported today, and it showed a sharp contraction of 2.2% in the first quarter (Q1)  of 2020, the worst result since 2008. The GDP for the fourth quarter of 2019 was also revised lower from zero to -0.1%, meaning Germany is now officially in a recession. Officials have predicted that the German economy will shrink this year by 6.3%, which would place Germany in its worst recession since quarterly GDP records began in 1970.

In the United Kingdom, Prime Minister Boris Johnson announced some easing measures for England, whilst Scotland, Wales and Northern Ireland remain in lockdown. Johnson’s update was met with some confusion, however the key changes from an economic perspective relate to the return of some construction and manufacturing workers. UK GDP results also showed a contraction for Q1 2020, down 2%. The services sector, which drives most of UK GDP performance, was down 1.9% on the quarter (more on this below).

Note, we also had eurozone GDP figures out today, which showed a 3.8% contraction in Q1 2020— the largest quarter-on-quarter drop since 1995.

In the United States worryingly, daily cases were on the rise last week and there was also a small increase in the number of deaths, too. Whilst the infection curve has shown definite signs of flattening, it is concerning that the rate of infection is showing little sign of a steady decline. New cases and deaths certainly remain elevated; however, that may come as little surprise given how quickly some states have been to re-open.

As we noted last week, South Korea experienced a sharp increase in infections through last weekend. Meanwhile, Wuhan reported its first new infections last week, whilst Russia, Brazil and Turkey all reported an uptick in infections and deaths.

United Kingdom: Slowdown in Focus

In the United Kingdom we saw Q1 2020 GDP come in at -2% compared with the last quarter, with the Chancellor of the Exchequer Rishi Sunak stating: “It is now very likely that the UK economy will face a significant recession this year, and we’re already in the middle of that as we speak.” Digging into the data, there were “widespread” declines across the services, manufacturing and construction sectors , with a record 1.9% fall in services output.

UK consumer spending will be a key factor in any recovery, and the latest data on household spending showed it shrank at the fastest pace in more than 11 years (although there was a rise in spending on food, alcohol and new TVs!).

A survey this week showed a third of UK manufacturers don’t see a return to normal conditions for over a year, which doesn’t really tie into the Bank of England’s (BoE’s) narrative that we will see a sharp V-shaped recovery in 2021. Previously, the central bank said the economy could shrink by 14% in 2020, the biggest decline since the Great Frost of 1709, before firing back with growth of 15% predicted in 2021.4

Finally, keep in mind the European Union/United Kingdom (EU/UK) Brexit talks are likely to come to a head in June, with the UK government reiterating it will not accept an extension of the transition deal beyond 2020. Today, UK negotiator David Frost says very little progress has been made, but he continues to believe an agreement is possible with EU.

Week in Review

Europe

It was a tough week for European equities as the tone of US/China negotiations deteriorated and concerns over the impact of the pandemic remain. Mixed economic data and a lack of progress in the EU/UK negotiations weighed on sentiment. Looking at sectors, health care and telecommunications outperformed, whilst the financials, automobiles and travel and leisure names struggled.

As we note above, it seems that with the current backdrop, rotation between baskets (value/momentum, winners/losers) is really driving markets, rather than individual stock fundamentals, even throughout earnings season. European stocks are currently trading near a record low vs. their US counterparts. The difficulty in agreeing on unified fiscal responses from EU member states likely exacerbated the dynamic. For its part, over the weekend the European Central Bank (ECB) said that it is ready to make further adjustments to support its policies.

With the travel and leisure sector one of the worst hit, last week the French government announced an €18bn fiscal package to support the tourism sector, as we note above. The industry represents around 9% of the country’s GDP and employs two million workers (almost all have been furloughed). Headlines over the weekend suggest there are hopes from Germany’s Foreign Minister Heiko Mass that talks with other EU members this week will make progress towards lifting a global travel warning and enabling members of the public to take travel on holiday this summer. This echoes commentary from France’s President Emmanuel Macron that individuals will be able to go on holiday in France in July and August. Importantly, Macron added that if new lockdown measures were implemented at this period, the government will reimburse bookings.

We are nearing the end of Q1 earnings season in Europe. The picture is mixed, with 51% of companies having beat consensus expectations on revenues and 49% beating expectations for earnings per share, although this is in the context of lowered estimates. The market’s upbeat performance does seem to indicate a willingness to look past poor results if the worst is avoided, but it’s important to remember that the second quarter is where companies are going to feel the main impact of the pandemic and related lockdowns.

United States 

Faced with the headwinds of fresh US/China tension and some cautious comments from Federal Reserve Chair Jerome Powell, it was not too surprising to see US equities give up some ground. Last week, the S&P 500 Index traded -2.3%, but overall trading volumes were notably lower than recent averages, suggesting there wasn’t too much conviction behind the move. The FANGS yet again proved versatile, ending the week slightly positive.

Looking at sector performance, the health care sector outperformed, trading +0.9% on the week, whilst energy names were the laggards, -7.5%.

Powell Comments: Comments from Powell in a US television interview over this past weekend caught investors’ attention. He stated: “Assuming there’s not a second wave of the coronavirus, I think you’ll see the economy recover steadily through the second half of this year”. However, he was cautious over when the US economy might regain get back to pre-COVID-19 levels. He stated: “For the economy to fully recover people will have to be fully confident, and that may have to await the arrival of a vaccine”.

Despite ongoing pressure from the White House to push interest rates into negative territory, Powell poured cold water on this possibility, commenting: “I continue to think, and my colleagues on the Federal Open Market Committee continue to think, that negative interest rates is probably not an appropriate or useful policy for us here in the United States”.

Macro data continue to highlight the unprecedented impact of the COVID-19 crisis, with US April Retail Sales falling more than 16% from the prior month.

Asia Pacific

Markets were broadly lower on the week in the Asia Pacific (APAC) region, with just Australian equities in the green as the tensions between the United States and China weighed on sentiment elsewhere in the region. There has also been more talk aver a potential second wave of the COVID-19 pandemic. China has now encouraged trading firms and food processors to boost inventories of grains and oilseeds as worsening infection rates elsewhere and the possibility of a second wave raise concerns about global supply lines.

With lockdowns eased for some time now, China’s April industrial production came in better than expected at +3.9%, and the unemployment rate was also stable at 6%. However, whilst there are signs of a pick-up in the economy, retail sales for April came were lower than expected, showing that the consumer sentiment remains wary and far from normal.

Week Ahead

Monday 18 May

  • Economic / Political: BOE’s Silvana Tenreyro speaks; ECB’s Hernandez de Cos speaks
  • Data: UK: (May) Rightmove House Prices; Switzerland Total Sight Deposits, Spain May Economic Survey, Italy May Economic Survey, Germany May Economic Survey, France May Economic Survey, Eurozone May Economic Survey; Japan GDP

Tuesday 19 May

  • Economic/Political: ECB’s Chief Economist Philip Lane speaks
  • Data: Germany: (May) ZEW Survey; UK: (Apr) Claimant Count, Jobless Claims, (Mar) ILO UR;  Eurozone: (Apr) New Car Registrations; Netherlands May Economic Survey, UK May Economic Survey, Switzerland May Economic Survey, Spain Trade Balance, Eurozone Construction Output, Eurozone ZEW Survey Expectations; Japan Industrial Production

Wednesday 20 May

  • Economic/Political: BOE’s Andrew Bailey, Ben Broadbent and Sir Jon Cunliffe speak
  • Data: Eurozone: (May, Adv) Cons Conf; UK: (Apr) CPI; Netherlands Consumer Spending & Unemployment Rate, Sweden Industry Capacity, Italy Current Account Balance, EZ ECB Current Account, Eurozone CPI

Thursday 21 May

  • Economic/Political: Turkey CBRT Meeting; South Africa SARB Meeting
  • Data: UK: Markit Manufacturing & Services Purchasing Managers Index (PMI); France Composite PMI, Germany Composite PMI, Eurozone Composite PMI; US Jobless Claims, Flash PMIs; Japan Trade and Flash PMI

Friday 22 May

  • Economic/Political: ECB Publishes account of monetary policy meeting
  • Data: France: Markit Manufacturing & Services PMI; Germany: Markit Manufacturing & Services PMI; Eurozone: Markit Manufacturing & Services PMI; UK: (Apr) Retail Sales; Switzerland Money Supply, UK Public Finances (PSNCR) & Public Sector Net Borrowing, Sweden May Economic Survey, Norway May Economic Survey; Japan CPI

 

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1. Source: Indices are unmanaged and one cannot directly invest in an index. They do not include fees, expenses or sales charges. Past performance is not an indicator or guarantee of future results.

2. Source: FANG refers to four popular US technology stocks: Facebook, Amazon, Netflix and Google (Alphabet).

3. The “R number” refers to the effective reproduction number, which measures the capacity for an infectious disease to spread. It represents the average number of other people an infected person will pass the virus to.

3. There is no assurance any estimate, forecast or projection will be realised.

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